Tuesday, 25 July 2017

The Bank of England Issues Yet Another Warning on the Credit Bubble

Today’s post reacts to the latest warning from the Bank of England regarding the ever-growing credit bubble, something which we have reviewed on a number of occasions here in Financial Regulation Matters. In addition to the previous warnings regarding the expansion of markets like the ‘Personal Contract Purchasing’ (PCP) market for cars, the Bank of England is now threatening even more regulatory supervision for credit lenders, which has been met with clear opposition from the marketplace. So, this post will look at these developments and continue to assess the likely causes and outcomes of this pressing issue.

On this occasion it was the turn of the Bank’s Director for Financial Stability, Alex Brazier, to address the issue of the growing credit bubble. In a speech to the University of Liverpool’s Institute for Risk and Uncertainty, Brazier commented that household debt is a truly systemic threat and that ‘the spiral continues, and borrowers rack up more and more debt. Lending standards can go from responsible to reckless very quickly. The sorry fact is that as lenders think the risks they face are falling, the risks they – and the wider economy – face are actually growing’. Also, in what is a common cause of financial downturns, Brazier noted that lenders ‘may be placing undue weight on the recent performance of credit cards and loans in benign conditions’, something which has been noted before in terms of placing too much emphasis upon the wrong indicators. For the Bank of England, one of the key indicators of this bubble is that in the six months after the E.U. referendum the British economy actually grew in opposition to expectations, which subsequently was revealed to be due to an increase in borrowing; we have looked at this before with regards to the diminishing savings ratio, the increased rate of people using their savings to spend, and the willingness, or arguably need, to borrow at increased rates. In response to these threats, Brazier stated that the Bank would consider imposing new and increased rates of financial reserves on Banks to ensure their safety with regards to their exposure to the explosion of the bubble.

Yet, one lender has made clear that they consider the Bank of England to be, for want of a better term, scare mongering. Provident Financial, a sub-prime lending firm, has stated that it has never changed its vigilance with regards to lending and has ‘not observed changes in customer behaviour in relation to either demand for credit or credit performance’. However, this rebuttal stands as a clear outlier because other statistics demonstrate a different reality. In the U.K. the outstanding balance on personal loans for cars, personal loans, and credit cards rose by 10% in the last year, and with regards to car loans there has been increasing concern with respects to increasing rates of delinquencies on both sides of the Atlantic. The issue then is what may be the cause of the bubble?

There are two lines of reasoning, primarily, to explain the growing credit bubble. The first is that countries like the U.K. and the U.S. have become accustomed to certain lifestyles that people are attempting to maintain without the necessary capital with which to do so. The official statistics point towards a continuation of spending in the areas of ‘restaurants and hotels, food and non-alcoholic beverages, recreation and culture, and miscellaneous goods’, with the latter being comprised of a number of elements including personal care, financial services, and insurance amongst other things including prostitution, oddly enough. However, whilst the rates of people buying new cars, via a multitude of financing options supports the sentiment that consumers are ‘binging’ on cheap credit, the other end of the scale is just as compelling. The fact of the matter is that not everyone who makes up the borrowing statistics are borrowing to purchase the latest Mercedes, BMW or Jaguar; rather, they are borrowing to live. Whilst we must place the dire situation in the U.S. to one side for just one moment, the situation in Britain is no better. A study by the University of Bristol found that the rate of ‘problem debt’ i.e. households unable to meet contractual payments, is rising and fundamentally affects those on the lower incomes in society. The report continues by confirming the links between home-ownership, inconsistent employment, age (households under 30), households with children, mental health and problem debt – which, as we know, is not a new connection to make. Once again, the issues of mental health, ill-health, and a lack of financial education/awareness are proven to be key factors in over-indebtedness and despite the efforts of regulators, predatory lending to these vulnerable groups has persisted, although now the offerings have been reduced and repackaged as ‘instalment loans’ (a movement led by Provident Financial, coincidentally).

All in all, whilst it is true that certain sections of the consumer base are binging on cheap credit to purchase items like brand-new cars, it is important that we do not let this cloud the reality of the situation. The current situation is a direct consequence of the Financial Crisis, whereby the poorest in society where left without to compensate for those who have. The era of austerity is driving vulnerable people towards modes of finance which not only perpetuate their vulnerability, but actually make them more vulnerable. The Bank of England, as is its remit, is right to look at protecting the largest financial institutions from exposure to the bursting of the bubble, but the real societal issue lurks underneath the headlines. The era of austerity has created a section of the population who have very little to lose but lots to gain from failing to meet their contractual agreements – the necessity of desperation is evident in today’s Britain, and the Bank of England’s warning provides support for the notion that there are companies that are more than willing to make a profit on that desperation; one wonders how many other warnings there will be.

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